Georgia: Country outlook

COUNTRY VIEW

ECONOMIST INTELLIGENCE UNIT
PUBLICATION DATE: August 01, 2005

OVERVIEW: The political scene will be dominated by the president,
Mikhail Saakashvili, particularly as a result of the sudden death of the
prime minister, Zhurab Zhvania, in February 2005. We forecast annual
average real GDP growth of 9% in 2005-06. The current-account deficit is
expected to remain high, particularly as import expenditure will rise
substantially as a consequence of pipeline construction.

DOMESTIC POLITICS: The political scene will be dominated by the
president, Mikhail Saakashvili, as a result of the death of the prime
minister, Zhurab Zhvania, in February 2005. Mr Saakashvili will
consolidate his authority in coming months and ensure that his allies
control the main levers of power. When Mr Zhvania was in power,
competition between the two politicians resulted in the government being
split into two distinct groups, with Mr Saakashvili and his supporters
controlling the security and military apparatus, and Mr Zhvania and his
allies retaining overall control of the economy. The late Mr Zhvania’s
associates are likely to become marginalised when it comes to
decision-making and power-sharing, given Mr Saakashvili’s political
ambitions and the fact that they lack Mr Zhvania’s political influence
and experience.

INTERNATIONAL RELATIONS: Georgia’s problematic relationship with Russia
will dominate international relations. Ties between the two countries
have been strained, owing to Georgia’s actions in South Ossetia, which
Russia considers to be its sphere of influence. Russia also alleges that
there is still a terrorist presence in Georgia’s Pankisi Gorge, which
has long been considered to be a refuge for Chechen rebels. Russia often
reiterates that it has the right to launch pre-emptive strikes on
terrorist bases outside its territory, raising the risk of an attack on
the Pankisi Gorge.

POLICY TRENDS: Reform efforts will include legislative, financial and
energy sector reform; privatisation; and further fiscal consolidation.
The government has made strides towards strengthening revenue
performance and implemented a new tax code in January 2005, but still
needs to make inroads into eradicating corruption and reducing
smuggling. However, the government’s progress in addressing these areas
is likely to be sluggish, owing to the weak enforcement of legislation,
including the inconsistent application of laws and bankruptcy procedures.

INTERNATIONAL ASSUMPTIONS: The global economy is experiencing a
slowdown. After an impressive performance in 2004, when demand rose at
its fastest pace for a quarter of a century, growth is softening in a
number of markets. The outlook for 2005-06 is still good, and the annual
rate of growth will be similar to that experienced in some of the best
years of the 1990s, but, in comparison with the heady performance of
2004, it will still represent a significant deceleration. We forecast
that world GDP growth, on a purchasing power parity basis, will slow
from a rapid 5.1% in 2004 to 4.2% in 2005, and to 4% in 2006.

ECONOMIC GROWTH: Growth in 2005 will be held back by a poor agricultural
harvest, following floods earlier in the year which destroyed much of
the 2005 crop. Since the agricultural sector traditionally accounts for
over 20% of total GDP, its performance has a significant impact on
growth. We have therefore revised downwards our forecast for real GDP
growth in 2005 to 8%. Better weather conditions in 2006 should result in
an acceleration of growth to 10% year on year.

INFLATION: High oil prices will exert inflationary pressures in 2005, as
will rising food prices, owing to a poor agricultural harvest, although
a decline in household energy demand in the second and third quarters
should partly offset this effect. The nominal strengthening of the lari
in 2005-06 will also reduce imported inflation. Year-on-year consumer
price inflation will therefore fall in the course of 2005 and remain at
similar levels in 2006, owing to solid economic growth, which will boost
employment and domestic demand. We anticipate annual average consumer
price inflation of 8% in 2005 and 7.8% in 2006.

EXCHANGE RATES: Foreign-currency inflows, in the form of workers’
remittances and external aid, are likely to remain high in 2005-06. The
lari will therefore continue to strengthen against the US dollar in both
nominal and real terms. The central bank will attempt to sterilise these
foreign-currency inflows, but, given the limited tools at its disposal,
it will only partly succeed. We forecast an average annual exchange rate
of rate Lari1.82:US$1 this year, followed by a rate of Lari 1.79:US$1 in
2006.

EXTERNAL ACCOUNT: Export revenue growth will be reasonably solid in
2005, owing to rising metals prices, but will temper in 2006 as
commodity prices fall. From the middle of 2005 the services balance will
benefit from a surge in crude oil transiting Georgia, when the
Baku-Tbilisi-Ceyhan oil pipeline becomes operational. Services credits
will rise further in 2006, when the South Caucasus Pipeline begins to
send gas to external markets. Rising transit revenue and workers’
remittances will help to keep the current-account deficit below 10% of
GDP in 2005-06.

SOURCE: Country outlook